Monday, April 23, 2007

Stock Tip: Buy What You Love. WRONG.

I heard it again over the weekend. A talking head on a business channel said you can make a fortune in the stock market by buying stock in companies whose products you love. "If you love a sweater, chances are your friends will too - buy the stock."
This advice can't be more wrong. It's wrong for two obvious reasons (but the advice like an unrelenting wronged mummy won't die).

Reason One: Just because a company has a great product, doesn't mean the company will make money. The company can have bad management, more nimble competition, or a patent lawsuit around the corner. For example, take the best product of the last millennium - Tivo. It's arguably the best invention since the flush toilet. All my fellow Tivo-people love their Tivos. We can't imagine going back to watching plain TV. With two Tivos, I happily send them $17 a month for a service that probably cost them $1. And yet Tivo stock is pretty much worthless. It's gone down from $70 to $6. I'm puzzled on why this is so. It's like a crack cocaine dealer coming back to his supplier saying, "Man, I just can't make any money moving this stuff."

Reason Two: The stock price can already be over-inflated by the time you buy. If everybody loved that type of sweater and bought stock the P/E ratio could be in the hundreds and no matter how much you love the sweater that ratio is unsustainable.

Buy stocks the old fasion way, based on the numbers and research, or better yet, buy index funds, but don't buy what you love.

PS: If you don't own a Tivo, pick one up on your way home today.

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